VAT Domestic Reverse Charge for the building and construction industry

After delays in 2019 and 2020, the Domestic Reverse Charge (DRC) rules for businesses operating in the building and construction industry will come into effect from 1 March 2021. The new rules are intended to tackle VAT fraud in the industry, by removi …

After delays in 2019 and 2020, the Domestic Reverse Charge (DRC) rules for businesses operating in the building and construction industry will come into effect from 1 March 2021.

The new rules are intended to tackle VAT fraud in the industry, by removing the opportunity for a supplier to charge VAT on an invoice and then not declare it or pay it over to HMRC.

The good news for businesses operating in the sector is that unless both parties to the transaction are VAT and CIS registered, normal rules will apply and no changes to invoicing and reporting will be required. Those supplies where the DRC is to be applied are known as “specified services” and the list of excluded services within the sector is small and specific.

For the avoidance of doubt, here is HMRC’s list of specified services where the DRC must be used when applicable, along with a list of when the DRC must not be used.

To summarise this further, the DRC will apply to specified services unless:

  • The services are supplied to an end user
  • The recipient makes onward supplies of those construction services to a connected company
  • The recipient is not UK VAT registered
  • The recipient is not registered for the Construction Industry Scheme (CIS)
  • The supplier and recipient are landlord and tenant or vice versa (known as intermediary suppliers), or
  • The supplies are zero-rated.

As the name suggests, the “end user” is the last point in the chain and will not be making any further onward supplies. For example, a subcontractor may do work for a contractor, who is in turn being subcontracted by a main contractor. That main contractor of the project will invoice the end user and will not reverse charge its supply, but the subcontractors will do.

HMRC state that the domestic reverse charge should be the default position for specified services, so unless written confirmation is provided stating than an end user is indeed that, then no VAT should be charged.

1 March 2021 – the important date:

VAT is due when a VAT invoice is issued, or payment is received, whichever is earlier.

For invoices issued for specified services that become liable to the reverse charge, the VAT treatment for invoices with a tax point:

  • Before 1 March 2021 – the normal VAT rules will apply and VAT should be charged at the appropriate rate on supplies
  • On or after 1 March 2021 – the domestic reverse charge will apply

How does it work?

Well, if a VAT/CIS registered subcontractor previously invoiced £1,000 + £200 VAT for their labour work to a VAT/CIS registered contractor, after 1 March 2021 that invoice will:

  1. Not charge VAT
  2. Need to state what VAT rate is applicable (i.e Standard or Reduced)
  3. Include wording along the lines of “Reverse charge: Customer to pay VAT to HMRC

This means the subcontractor will be owed £1,000 instead of £1,200. For the subcontractor’s VAT return, only the net sales figure of £1,000 will appear in Box 6, with £0 appearing in Box 1.

For the contractor receiving the invoice from the subcontractor, they will be required to calculate the VAT due (this is why the VAT rate should be stated on the invoice even though VAT is not being charged) and this figure is entered into both Box 1 and 4 of the VAT return. This offset means there is no impact on the VAT liability here. The net purchase is entered into Box 7 as usual.

Cash flow impacts:

This will have an impact on cash flow for both the contractor and the subcontractor, who will be receiving less than prior to 1 March. This could lead to subcontractors moving from being VAT payable businesses to being due refunds, as their output VAT will reduce or potentially disappear entirely depending on their customers’ circumstances. To mitigate this, the option of switching to monthly VAT return submissions is available whereby VAT refunds should be received on a more regular basis than quarterly.

The contractor will temporarily be better off as they would not be paying the gross amount to their subcontractor, but this evens itself out come VAT return submission, as there is now no input VAT deduction to reduce the VAT liability.

The end user raises its invoice under normal rules, charging VAT and adding the VAT to Box 1 and thus paying this output VAT to HMRC.

So where previously an output VAT amount for one business would be offset by an input VAT amount for another business, those steps will be removed from the chain, and thus the opportunity for the output VAT not being paid over to HMRC is removed.

Flat Rate scheme traders:

For those on the flat rate scheme who are affected by the DRC rules it is necessary to consider whether remaining on the scheme is in their interests.

This is because reverse charge supplies are not accounted for in the flat rate scheme so these supplies will not benefit from a reduced rate of VAT payment, while input VAT on purchases also cannot be reclaimed. Transferring across to the Standard VAT accounting scheme will be more beneficial as the input VAT can be reclaimed, potentially leading to repayments being due.

A “light touch” approach:

As with HMRC’s introduction of Making Tax Digital, HMRC have recognised that this change is going to take some time for everyone involved to get up to speed and have stated that a “light touch” approach will be taken for the first six months after the rules come into force. Therefore as long as businesses are seen to be trying to comply with the new legislation and not trying to take advantage of the measures then penalties should not be considered, but it is important that all those impacted, from business owners and their staff to accountants and bookkeepers become familiar with the new rules.

Software:

It is important that businesses ensure their accounting software is prepared for these changes. Xero has introduced new tax rates which can be added to the existing rates for their users, and in addition to this are hosting a webinar at 10am on Friday 26 February, which is available to all users and will give insight into how the changes to bookkeeping processes can be dealt with. If you wish to sign up for this webinar the link is here.

Written by Rob Ward – Small Business Unit Manager